Taxes From A To Z (2018): A Is For Annual Contribution Limits

It’s my annual "Taxes from A to Z" series! If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss, you won’t want to miss a single letter. Here's the kick-off:

A is for Annual Contribution Limits.

Each year, the Internal Revenue Service (IRS), the IRS announces annual contribution limits for certain retirement plans. The adjustments are required by law.

The specific language is found at section 415(d) of the Tax Code which directs the Treasury to make the adjustments each year. The language goes on to specify that the adjustment should be made "with respect to any calendar year based on the increase in the applicable index for the calendar quarter ending September 30 of the preceding calendar year over such index for the base period" using procedures "which are similar to the procedures used to adjust benefit amounts under section 215(i)(2)(A) of the Social Security Act."

The procedures outlined at section 215(i)(2)(A) of the Social Security Act are pretty extensive but generally require the government to examine the overall cost of living and determine whether an increase is necessary. There are a number of formulas involved but the easiest way for most folks to determine whether those numbers will be on the way up or down is to look at the consumer price index (CPI). The U.S. Bureau of Labor Statistics reports whether the CPI has moved up or down. That's important because the CPI measures the cost of goods and services - in other words, your cost of living. The CPI tends to signal what's going to happen with interest rates - and inflation. A number of those the items you'll see in the Tax Code are dependent on inflation.

So what does that mean to you?

When the numbers don't move much, it means that interest rates are likely staying put. Relatively flat interest rates can be a good thing from a financial perspective, especially if you have adjustable rate mortgages, student loans, or other debt.

When the numbers edge up, that means that inflation may be on the way up. And while that feels like it's a scary thing, it's not always: If the annual contribution limits go up, that means there's more available for you to sock away for retirement.

Outside of inflation, the other significant way that annual contribution limits can change is through legislation. And that's exactly what some taxpayers feared with the Tax Cut and Jobs Act of 2017. Changes to retirement plans - including limiting contributions - were on the table. But in the end, there were no significant changes, as detailed in a February 6, 2018 statement:

The Internal Revenue Service today announced that the Tax Cuts and Jobs Act of 2017 does not affect the tax year 2018 dollar limitations for retirement plans announced in IR 2017-177 and detailed in Notice 2017-64.

For the specific 2018 retirement plan contribution limits, check out this post by Ashlea Ebeling.